OK, That Was Bad; Where To Now?

I’m pretty fond of reminding readers that when you pan out to the asset class level (i.e., beyond sectors and well beyond individual stocks, although thanks to the dominance of FAAMG, a handful of names are becoming uncomfortably synonymous with the entire equity market), making predictions with any degree of specificity is a fool’s errand. The best anyone can do is try to understand the prevailing dynamics, develop innovative frameworks for analyzing those dynamics, then build on that over time on the way to developing a nuanced take on markets.

This requires taking a holistic, cross-disciplinary approach and it’s what research should be about. Attempting to understand markets through an innovative lens, building on an existing body of work to push the discussion forward, and fleshing out the concepts proposed in that previous work as part of an ongoing effort to explain phenomenon by reference to frameworks that seem to have some explanatory power.

Obviously, individual stock analysis is a different animal and to the extent you can become an expert in this or that sector by virtue of some specific skill set you happen to have (like say, you’re a doctor and you’re analyzing drug stocks), well then sure, you might be able to make some prescient predictions now and again. But even there, I would argue that everyday investors, no matter how much expertise they might have, are fighting an uphill battle because when it comes to big-cap stocks, Wall Street has an almost insurmountable informational advantage in terms of access to experts and, more importantly, a direct line to management. Throw in the fact that the Street does business with a lot of the companies the analysts cover and what you come away with is a situation where the chances of you figuring out something about a well-covered stock that the Street hasn’t already figured out are basically zero.

Of course, people will tell you they “correctly” predicted longer-term moves in entire asset classes all the time and they’ll be able to make what seem like convincing arguments in support of that contention by virtue of things having turned out like they did. It reminds me of something the President said in a speech this week at a GOP congressional retreat. Here’s the quote:

Now we’ve fulfilled more promises than we promised.

That’s a lot like what you’ll hear from some of the more ardent bulls who lean on economic fundamentals to support their position. Years ago they suggested that the global economy was going to get back on solid footing and that earnings would eventually start growing at a decent clip and now they’re pointing to those global PMI checkerboards that are showing a synchronized expansion across countries and the dramatic upward revisions to EPS estimates in the U.S. and saying “now we’ve fulfilled more promises than we promised.”

The point is, saying that over the long-run stocks go up and then saying that’s usually attributable to the fact that economic progress is (periodic interruptions notwithstanding) inevitable, isn’t exactly a Fields-worthy observation. So there’s something a bit disingenuous about pointing to evidence of it over time and taking credit for having “predicted” it.

Much harder than predicting that over the long-haul stocks rise, is predicting how much stocks will rise over shorter horizons or, if the horizon is short enough, if they might even fall. This is where the effort to predict where stocks, as an asset class, will be a month, a year, or even five years from now, breaks down entirely. And the thing is, I’m not trying to malign the people whose job it is to try and make those predictions. It’s just that what they’re tasked with doing is impossible, so what you end up with are scenarios where markets blow through nearly 50% of the Street’s year-end targets in the first four weeks of the year, which is what happened in January. Here’s a fun chart that shows you how Wall Street’s year-end S&P targets were holding up as of January 17:

(Heisenberg)

But the best (and by “best” I mean funniest) visual is this one:

(BofAML)

That’s from BofAML’s global fund manager survey, and as you can see, the percentage of respondents predicting an equity market peak in Q1 fell materially from the December survey to the January survey because, well, because if what you were going by was January, well then the S&P looked like it might be on its way to 10,000 (that’s a joke, but you get the point).

All of that underscores the inherent futility in trying to make accurate “calls” about broad asset classes and this is why, when readers get frustrated with me for not attempting to tell you the exact moment to sell, I typically don’t respond. Making those kind of predictions is fruitless. It’s a guessing game, plain and simple.

That said, you should note that there are times when circumstances conspire to make a short-term outcome all but a foregone conclusion. Last week was an example of that. I detailed those circumstances exhaustively here on Friday evening in a post aptly called “A Bad Dream”. Long story short, if you’ve been paying attention for the last five years, you know that one of the main risks for equities is a sharp selloff in bonds; a “tantrum”. January witnessed an acute bond rout and all you had to do last Sunday was take two minutes to glance at the calendar for the coming week to know that a worsening of that rout was all but inevitable.

Now that’s out of the way and we’re kind of back in a position where everyone is asking for predictions again only now, everyone wants to know how far markets will fall, whereas just a week ago, the question was how high markets will rise.

Guess what? I’m not going to answer that question for you because as noted above, I don’t have that answer and neither does anyone else. Again, you might be tempted to think that just because Goldman (last Monday, they said there’s a “high probability” of an imminent correction) and BofAML (they literally suggested clients sell two Fridays ago) and Heisenberg (I told you the Treasury selloff needed to stop “right now” late Monday night) and multiple other desks seem to have seen this week coming, that it represented some kind of “validation” of a bear thesis. I disagree. What you saw this week was a confluence of factors conspiring to make a quick move lower all but inevitable. Not to put too fine a point on it, but if you didn’t see this week coming last weekend, well then you probably don’t know that much about how different assets interact with one another.

So while I won’t even try to pretend that I can be that prescient with regard to what happens next, what I would suggest is that folks are still woefully offsides if what we saw over the past five sessions ends up morphing into something worse. I highlighted four charts from Deutsche Bank over at my site on Friday, but I’d be willing to bet that only a small fraction of my readership on this site saw them, so I wanted to point them out here as well. Here they are, with a sentence from the accompanying color from Deutsche:

Aggregate shorts in cash equities and ETFs, led by cuts in Tech shorts, have for the first time fallen below the elevated range they have been in since the financial crisis.

Margin debt in brokerage accounts has risen to extremes:

While cash balances have fallen below the normal range:

DM3

Option market indicators had till last week painted a similar picture with the put/call ratio low:

Inflows into equities have surged recently to the largest monthly inflow on record:

In the same vein, take a look at the following chart from Goldman which shows that according to CFTC equity futures positioning, “investors increased long US equity positions by $40 billion this year, bringing long and net positions to new record highs”:

(Goldman)

See what I mean? Some of that underscores what Salient’s Ben Hunt wrote last week about everyone abandoning their “talismans” and just generally convincing themselves that the “things that go bump in the night” (to quote Ben) don’t exist.

On the anecdotal front, have a look at this fun Google trends chart:

(Google Trends)

Some folks were trying to figure out how to buy stocks in January, and although drawing conclusions from Google trends charts is of course a silly thing to do, it’s worth noting that the last time laypeople were this interested in getting in, there actually was a meaningful dip, whereas that spike in January came at a time when the market was going up literally every, single day.

On the bright side, you should note that things don’t always turn out like they did in 1987 (a comparison more than a few people have been making lately). In the interest of closing on a positive note tied to those comparisons, I’ll leave you with the following from Goldman:

By focusing on 1987, investors overlook other historical episodes that suggest a much better outlook for US equities in 2018. Of the 12 other years since 1950 that started with a January return greater than 5%, 1987 is the only one in which the February-December return was negative. Across all episodes, the median 11-month return was 17%.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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